Use tax mistakes manufacturers can’t afford to make

Key takeaways

• Use tax can be particularly complex for manufacturers, which means these businesses are at significant risk of fines and penalties in an audit.
• Because use tax is misunderstood, it’s common for people to incorrectly assume that no tax is due if sales tax isn’t charged.
• It’s easy for businesses that manage many SKUs and frequently shift inventory to incur new tax obligations without realizing it.

A ‘hidden’ tax with big risk

At Avalara, we talk a lot about helping businesses reduce risk — and for manufacturers, there’s perhaps no greater risk (at least from a tax perspective) than use tax. This self-assessed tax with complex rules can be confusing for any company, but manufacturers have it particularly rough. Here are just a few reasons why:

• A business might owe use tax depending on whether materials become part of a final product or simply play a role in the production process.
• It can be difficult to understand tax risk related to procurement, such as whether things like forklifts and R&D equipment are subject to use tax — because in some jurisdictions items are exempt only if they directly change the product.
• Certain changes can create taxable events without a business realizing it, such as when items are removed from inventory for promotional use or transferred between plants.

Like with most other taxes, the rules for use tax aren’t consistent across jurisdictions, which only adds to the headache — especially if your business has operations, sales, and/or vendors in multiple states. And auditors know this, which is why manufacturers are a prime target for states looking to boost revenue.

So how can you avoid getting burned by manufacturing tax errors? A good start is avoiding these five key use tax mistakes.

1. Assuming ‘no sales tax’ means ‘tax free’

Use tax can be confusing, even for tax professionals, so it’s important to ensure your team understands what it is and when it could apply for your business. Everyone has a basic idea of what sales tax is, so it’s easy for people to assume if a vendor doesn’t charge it on a particular purchase, that must mean no tax is owed. That’s not always the case.

2. Not understanding state differences

When it comes to state-specific rules, use tax rates are just the tip of the iceberg. Some states follow a “direct-use” approach to taxability, which provides manufacturers with tax exemptions on equipment only if it directly creates a physical or chemical change to a final product for sale. Meanwhile, the “integrated-plant” rule in other states is broader and can apply to things that help in the overall production process.

A forklift provides a good example: Classified as MRO (maintenance, repair, and operations) supplies, it’s likely not tax-exempt equipment in a direct-use state. But in an integrated-plant state, it might be. This can be either a risk or an opportunity — are you taking advantage of all the exemptions you qualify for? Or are you taking exemptions you don’t deserve?

3. Not ‘self-auditing’

No, you don’t have to do everything a state auditor would do, but businesses should absolutely have processes in place to examine and validate the tax impacts of purchases, items that move into and out of inventory, and other points that can lead to problems. Let’s say you purchase materials without knowing for sure how they’ll be used. Do you have a tax accrual process for these situations? If not, you might end up under- or overpaying.

You also need to watch your vendor transactions closely. If vendors aren’t correctly applying your exemptions based on the items you’re purchasing (and how and where those items will be used), you could be overpaying. Or you could be underpaying — and remember, even if it’s a vendor making the error, that doesn’t mean you’re off the hook.

4. Thinking the state will offer up a refund

If you underpay sales or use tax, the tax authorities are definitely going to let you know. Wouldn’t it be great if the same held true for overpayments? Unfortunately, it doesn’t work that way. That’s why it’s so important to stay on top of your obligations; just as you don’t want to underpay and face potential fines and penalties in an audit, you also don’t want to overpay and provide the state or other jurisdiction with what amounts to an interest-free loan. It’s on you to manage (and to request a refund if you find out one is warranted).

5. Trying to manage it all on your own

This might be one of the biggest mistakes of all. If you’re trying to manually track all of this across various jurisdictions (let alone across many different SKUs and pieces of equipment), you might be in for an unpleasant surprise, especially if your business is growing and expanding operations.

Use AI to manage use tax compliance

Today’s complex tax environment requires powerful solutions that can keep up with ever-changing regulations — while freeing up time and resources your business can put to better use than manually tracking use tax.

Avalara AvaTax for Accounts Payable is an AI-driven solution that takes the burden off your team, reduces risk, and even creates opportunities: Over 200,000 direct and indirect Avalara customers utilize the power of our tax automation software to more efficiently manage their tax obligations and set the stage for growth.

What can Avalara AvaTax for Accounts Payable do for your business?

• Manage use tax compliance, setting limits for undercharging and overcharging to ensure every transaction is in alignment with expectations.
• Catch vendor errors and limit your liability.
• Automate use tax compliance by applying use tax owed on your returns automatically.
• Centralize tax compliance to manage sales, purchases, and returns.
• Streamline review processes and identify high-risk vendors for closer evaluation.
• Create advanced, custom rules through agentic AI with support from Avi, our Avalara AI assistant.

With our purpose-built manufacturing solution, you’ll be alerted to discrepancies immediately and have better visibility into your tax compliance processes. Most important, you’ll stop money from slipping through the cracks.

FAQ

What is use tax?

Use tax applies to the storage, use, or consumption of taxable property or services when sales tax was not charged at the time of purchase. One example: You purchase an item from a seller that doesn’t have nexus in your state, so they don’t charge sales tax. Depending on your state’s rules, you may owe use tax on that item.

Why is it so complicated?

Use tax is self-assessed, with rules that vary across states and jurisdictions. Because of this, it’s easy for it to sneak up on a business — something as simple as a manufacturer shifting inventory between plants can create a tax obligation.

Can automation help?

Avalara has designed a purpose-built manufacturing solution that helps businesses manage use tax along with a vast array of other compliance obligations. With the power of agentic AI, Avalara can ease the burden of use tax, reduce risk, and allow you to focus resources on more important things — like growing your business.

How does Avalara use AI?

AI plays a key role in our solutions for tax compliance automation. Avalara Agentic Tax and Compliance™ features AI agents that can independently handle repetitive and complicated tasks, freeing up time for your team and catching errors that are easy for humans to miss. Agents can calculate use tax across jurisdictions, validate and file exemption certificates, and do much more — all while allowing you to focus valuable resources elsewhere.